naked capitalism

This is a great post, “Why Market Leaders Don’t Listen to Investment Bankers,” by Charles Green at HuffPo.

The set-up for this story is why it isn’t so dumb for companies to keep a lot of supposedly unproductive cash on hand. You can make similar argument for why companies shouldn’t divest their cash cows. A lot of Big Pharma has sold various consumer goods companies (my pet peeve: Bristol Myers selling Clairol, a company that coins money) that provided steady cash flow which helped fund their long-time-horizon drug development business. I for one would not want to depend on the whims of the capital markets if I were in a business with high, ongoing needs for investment.

And towards the end, Green makes another point: that the slicing and dicing of activities into smaller and smaller, more specialized pieces (Adam Smith’s pin manufacture carried out as far as possible) has gone beyond the point of maximum advantage. The problem is twofold: as we have learned in structured finance, there is the risk of loss of vital information when projects through too many hands. And relying on a sequence of specialists means that the buyer/client has to integrate and provide the big picture overview, when he may lack the skill to do so.

I see this play out in my own field, where dissatisfaction with consultants is growing, and has been created by the industry. Consultants increasingly offer packaged products because they are easier to sell than custom work, and give the illusion of certainty. But to buy the right product, you have to have made the correct diagnosis. Clients often wind up unhappy because the consultant didn’t solve their problem, but they are partly culpable for having gone for the easy out of a slick-sounding solution rather than the tougher process of coming to grips with their issues.

From Green:

I spoke to the (non-American) former CEO of a large company–the profitability leader in its capital-intensive global industry…..

“I used to get calls from them–Morgan Sachs, Goldman Stanley, you know–the supposed crème de la crème of MBAs. Here’s how they went:

Bankers: Why do you keep so much cash? Your leverage ratio is half that of your industry. You’re earning nothing on it–it’s like keeping shareholders’ funds under a mattress. You’re destroying shareholder value….

CEO: Let me ask you–who’s the global market leader in software?

Bankers: Microsoft, of course.

CEO: And how much cash do they have on hand?

Bankers: Way more than the industry average; too much; they should return it to the shareholders.

CEO: Uh huh. And who’s the global market leader in semiconductors?

Bankers: Intel, of course.

CEO: How much cash on hand?

Bankers: Again, way too much, more than industry average, they’re destroying shareholder value.

CEO: Uh huh. I too am the market leader, and the profitability leader….

My industry–like every capital-intensive industry–has cycles. I buy my expensive assets at a huge discount–when the market is cold and my suppliers have no backlog. I get what I want, when I want it, pay less, and have grateful suppliers. My competitors buy when their profits are high–they overpay, wait years for delivery, and irritate their suppliers–as do their competitors.

I make strategic moves when I’m the only one who can do so. My competitors make their moves along with everyone else.

I can do all this because I have cash. My competitors all listened to your advice about copying the average. Not only am I the only one with funds to execute my strategy–I’m the only one thinking of a unique strategy….

Q. Who’s right?

A. The CEO–hands down, a no-brainer.

Q. How could the bankers so spectacularly miss something so obvious?

A. The blinding power of an unchallenged paradigm.

Q. And what paradigm would that be?

A. Ah, that’s the big question. Is it:

1. Youth is arrogant

2. Business has become overly quantitative and analytical

3. Finance has triumphed over marketing and production

4. Paris Hilton was somehow involved

5. We are killing off strategies and relationships for the sake of transactions.

I vote #5–death by transactions.

The history of capitalism is one of scale economies, enabled by parceling out pieces of work to others. Every time you do that, you gain scale–and you create a transaction.

This trend has accelerated: more chunks of business are being chopped up and parceled out–both in space and in time.

Examples:

* Modular software
* Mortgage (and other asset) collateralization
* HR competency models
* Outsourcing
* Globalized sourcing

This habit is reflected even in meta-patterns of business thinking–how to tackle a problem? Break it up, break it down. Analyze it. Measure it. Parcel it out. Track it. Install rewards. Repeat at one level of detail lower.

Every time you break up a function and parcel it out to more people over less time, two things happen. Greater efficiencies–and less relationships.

Repeat infinitely, and you get people who think about business like tinker-toys–models to be constantly assembled and re-assembled.

That way of thinking often fosters neither strategic nor relationship thinking.

It is also impossible to think ethically when there are no relationships to be harmed, and no timeframe in which to be held accountable.

But the biggest irony is: it may not be working anymore. The chop and parcel game has been played out. The returns are beyond diminishing; the cost of the transactional mindset is exceeding the savings of scale. The game has turned dysfunctional.

Death by transactions.